The implications of retail-sector liberalisation: Evidence from Romania

Beata Javorcik, Yue Li 15 February 2013

Retailing has experienced disruptive technology progress in recent decades – what might be called Walmartisation. This column explains how the entry of global retail chains may transform the retail sector and the supplying industries in the host economies. Focusing on the Romanian case, it shows that a 10% increase in the number of foreign chains’ outlets is associated with a 2.4% to 2.6% increase in the productivity in the supplying industries.

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Retailing is a sensitive sector in most nations. It is highly visible to consumers and voters, employs many people, and has experienced disruptive technology progress in recent decades – what might be called Walmartisation (see Iacovone et al. 2011).

One particularly important recent example can be found in India, where retail-sector liberalisation grabbed the headlines in 2012. India is still a nation of small shopkeepers, where only 10% of total retail sales between $450 billion and $500 billion a year take place in modern stores. In September 2012, the government, led by Prime Minister Manmohan Singh, announced the reform to allow 51% foreign direct investment in supermarkets and department stores, as a part of an unexpected and ambitious reform package. Only a year ago, the government had to back down on a similar reform in the face of stiff opposition from politicians and small shopkeepers.

According to the details of the announcement, foreign investors need to meet a list of requirements and individual states have the right to opt out from the retail-sector reform. So far only ten states said they would allow global retail chains like Wal-Mart, Tesco and Carrefour to enter. Foreign investors are only allowed to operate in and near cities with populations of at least one million – there are 53 such cities. Foreign investors are required to invest at least $100 million and to buy 30% of their supplies in India.

What can the states that have opted to open their retail sector gain, and what will the states that have not forgo? The supporters of the reform expect the first movers to set examples for the laggards. But, the impact will take time to materialise, thus experiences from other developing countries may help to shed some light on this question now.

The entry of global retail chains may transform the retail sector in the host economies and, more importantly, may affect the supplying industries.

Global retail chains differ from indigenous retailers not only in terms of scale but also in terms of their access to global sourcing networks, advanced technologies and modern management strategies.

Their entry often changes the landscape of the retail sector in the host country through increased concentration and modernisation.

Their expansion may have implications for supplying industries in terms of lowering distribution costs, stimulating economies of scale, and increasing competition due to a greater ability of foreign retailers to source products from abroad.

The competition effect may in turn encourage productivity improvements and innovation among suppliers. It may allow more innovative and productive firms to grow at the expense of those with obsolete technologies and thus improve allocation efficiency.

New evidence

In a recent study, we provide empirical evidence on the implications of retail-sector liberalisation in Romania (Javorcik and Li 2013). During 1997-2005, foreign chains rapidly became important players in the Romanian retail sector. Their employment increased from virtually zero to more than 18,900 in 2005, when they accounted for almost a quarter in total retail sales (see Figure 1).

We find that during this period the Romanian retail sector witnessed high rates of job churning and market reallocation, followed by a sizeable increase in labour productivity. Entry and exit played a critical role in the reallocation; 62% of employment expansion was due to entry of new firms, while 23% of employment contraction was accounted for by exiting firms. We document a sizeable (17%) increase in labour productivity in the retail sector and show that entry of new firms and expansion of more productive firms at the expense of lesser performers was the main driver behind this development.

Figure 1. Expansion of global retail chains in Romania

Source: Authors’ calculations based on the Amadeus database.

We investigate how these drastic changes in the retail sector affected manufacturing industries. We rely on the differences in the speed of the expansion of global retail chains across 42 Romanian counties (Figure 2) and the fact that only supplying industries should be affected by the chains’ presence. More specifically, for each county we calculate a measure of access to foreign retailers. It is defined as the sum of the number of foreign outlets (or their selling space) in all counties in Romania weighted by the inverse of their distance to the county where the manufacturer in consideration operates. Supplying industries are defined as those producing food and beverages, which are the core products sold by supermarkets. We then relate the total factor productivity of manufacturing firms to the proxies for access to foreign chains, and ask whether supplying industries are affected differently by the foreign chains relative to other industries.

Our results suggest that the performance of upstream industries is positively correlated with access to foreign retailers.

The magnitude of the effect is economically meaningful: a 10% increase in the number of foreign chains’ outlets in Romania is associated with a 2.4% to 2.6% increase in the productivity in the supplying industries.

An alternative exercise focusing on eight Romanian regions suggests that the presence of a foreign chain in a region raises the productivity of the supplying industries by 3.8% to 4.7%.

We further decompose the aggregate productivity in the supplying industries, following Olley and Pakes (1996) and Pavcnik (2002). The decomposition indicates that the boost to performance is driven by both intra-firm improvements and inter-firm reallocation. Both changes are found to be associated with the expansion of foreign chains.

Overall, our results suggest that the opening of the retail sector to foreign investment may stimulate productivity growth and improve allocation efficiency in manufacturing industries and thus provide another piece of evidence in favour of services liberalisation.